ANALYSIS: California’s offset market to face lingering supply drought

Published 05:03 on July 24, 2015  /  Last updated at 02:48 on July 25, 2015  /  Americas, US  /  No Comments

California’s supply of carbon offsets will significantly undershoot allowable limits for 2020, with project developers hampered by an insufficient number of protocols and unfavourable conditions stemming from the uncertain future for the state’s cap-and-trade scheme, participants say.

California’s supply of carbon offsets will significantly undershoot allowable limits for 2020, with project developers hampered by an insufficient number of protocols and unfavourable conditions stemming from the uncertain future for the state’s cap-and-trade scheme, participants say.

Compounding the structural weaknesses in the market is the current low price of California Carbon Allowances due to oversupply – a condition that leaves many potential projects out-of-the-money due largely to the risk-based discounts shown by offset prices compared to CCAs.

Market participants say it’s uncertain what price impact – if any – a shortfall in offset credits will have on California’s ETS, which is forecast to be oversupplied with allowances through 2020.

Also unclear are the supply-and-demand fundamentals for the relatively new offset market, a small component of California’s broader ETS.

“We haven’t seen a lot of uptake [of offsets], but there’s been only one surrender,” said Gary Gero, president of the Climate Action Reserve (CAR). “That’s not a significant data point.”

Others echoed that view.

“We’ll know much better about demand in November when we see what people have retired,” said Robert Parkhurst, director of agricultural greenhouse gas markets for Environmental Defense Fund (EDF), referring to the upcoming Nov. 1 deadline to surrender carbon units for 70% of 2013 emissions and 100% of 2014.

LOW SUPPLY

Under California’s ETS, utilities and transportation fuel providers operating in the state are allowed to meet 8% of their compliance obligations with offsets.

That translates into an allowable state-wide limit of 242 million offsets by 2020, an estimate that assumes all compliance entities would – or could – take advantage of their full allotment.

But analysts expect California’s Air Resources Board (ARB) to issue a much smaller number of credits based on market trends and prevailing regulatory conditions.

In a May forecast, Thomson Reuters Point Carbon predicted that ARB will issue just 121 million offsets by 2020, a decrease of 25 million from a previous estimate.

ARB had issued just over 21.5 million credits by mid-July.

Point Carbon downgraded its expectations for output under every available offset protocol except for those related to forests.  However, it said that recent rule changes to the forest protocol could shave as much as 10% from their estimate, which at 58 million tonnes represents the largest segment.

Their forecast also downgraded supply from the ozone-depleting substances (ODS) protocol by 13% to about 45 million tonnes, in part due to industry concerns related to ARB’s decision to invalidate a number of credits generated by Missouri-based Clean Harbors over regulatory violations, which were not related to the offsets program.

But even a 13% cut might be conservative.

“Clean Harbors is no longer taking on ODS projects, and other facilities don’t have the capacity to take on the same volume of projects,” said CAR’s Gero.

MODEST DEMAND

Regardless, Point Carbon did not consider its downgrade to be market-moving given the abundant allowance supply.

The analysts did acknowledge that an inadequate quantity of offsets could become an issue in 2018 if the market seeks to use more of them, as they are discounted against allowances by as much as 5-25%.

Still, many participants including Gero think that supply will follow demand.  However, more demand could be a long way off as CCAs are seen remaining near their price floor for the foreseeable future.

An annual forecast published by CAR last October foresees an offset surplus through 2017, even in the unlikely event entities use their full 8% allotment.

But EDF’s Parkhurst doesn’t share in the pessimism, adding that he “doesn’t think there are enough offsets to cover the necessary demand”.

He pointed out that issuances are at about 85% of the allowable volume for the 2013-2014 period, and that the market needs to generate four times more as transportation fuel providers join the ETS this year.

“I think the real issue is getting people to generate the credits,” he added.

NEW PROTOCOLS

According to Parkhurst, that means ARB must open the market to further development by approving more protocols – an opinion widely held by industry experts that spoke with Carbon Pulse.

EDF was a key proponent of the rice protocol approved by ARB last month, but market participants say it has limited potential to boost offset supply  due to the relatively small amount of US land used for cultivation.

“We see minuscule amounts, less than a million tons total coming from rice management,” said Point Carbon’s Olga Chistyakova.

Still, Parkhurst is counting on rice becoming a stepping stone for other crop-based offset protocols.

“We see tremendous potential for fertilizer optimization,” he said, noting that such a protocol could be implemented on as a 100 million acres. “We want to leverage that.”

Alastair Handley, president of Carbon Credit Solutions, an Alberta-based project developer, welcomes the idea, adding “I think it’s on the horizon.”

But that horizon might be too far off to help fill the supply pipeline for 2020, as the pay-off window for new projects begins to narrow.

“These projects are looking at getting paid $10 per tonne – and only through 2020,” said Peter Weisberg, program manager for The Climate Trust, an Oregon-based offset developer that’s just dipping its toes into California’s compliance market.

Weisberg said his organisation seeks to invest in projects based on yields over 10 years, and that three or four years of credits is not worth financing.

“Having some greater certainty about the longevity of the market would help,” he added, referring to the California ETS’ post-2020 future.

A bill that would extend it indefinitely is moving through California’s legislature, along with legislation requiring the state to reduce its GHGs by 40% below 1990 levels by 2030. Both are expected to pass and be signed by Gov. Jerry Brown by October.

EDF’s Parkhurst called the development of these bills “a momentous milestone”, but added that the upcoming compliance deadline should provide the signal the market has been waiting for. adding “we have yet to see what will happen with the market.”

But for Parkhurst, the upcoming November compliance deadline should provide the signal market participants have been waiting for.

By Robert Mullin – news@carbon-pulse.com

Tweet about this on TwitterShare on LinkedIn0Share on Facebook0Share on Google+0

Comment

We use cookies to improve your website experience and to analyse our traffic. We also share non-personally identifiable information about your use of our site with our analytics partners. By continuing to use our site, you agree to this. More information

The cookie settings on this website are set to "allow cookies" to give you the best browsing experience possible. If you continue to use this website without changing your cookie settings or you click "Accept" below then you are consenting to this.

Close